Microeconomics Presessional September 2015 Sotiris Georganas Economics Department
Microeconomics Pre-sessional September 2015 Sotiris Georganas Economics Department City University London
Organisation of the Microeconomics Pre-sessional o Introduction o Demand Supply 10: 00 -10: 30 -11: 10 Break o Consumer Theory 11: 25 -13: 00 Lunch Break o Problems – Refreshing by Doing o Theory of the Firm 14: 00 -14: 30 -15: 30 Break n Problems – Refreshing by Doing 15: 45 -16: 30 2
Demand Supply q The Market Demand Function q The Market Supply Function q Equilibrium q Characterizing Demand Supply q Elasticity September 2013 3
Competitive Markets N buyers M sellers M and N large enough that no agent can influence the market price September 2013 4
The Market Demand Function The market demand function tells us how Qd (the quantity of a good demanded by the sum of all consumers in the market) depends on various factors Qd = Q(p, po, I, …) The Demand Curve The demand curve plots the aggregate quantity of a good that consumers are willing to buy at different prices, holding constant other demand drivers such as prices of other goods, consumer income, and quality Qd= Q(p) September 2013 5
Derived demand, Direct demand, Market demand curve The Market for Corn in the United States, 1996 September 2013 6
Reminder When we graph demand (and supply) functions, we always graph P on vertical axis and Q on horizontal axis, but we write demand as Q as a function of P. If P is written as function of Q, it is called the inverse demand. Normal Form: Qd=100 -2 P Inverse form: P = 50 - Qd/2 September 2013 7
The Law of Demand states that the quantity of a good demanded decreases when the price of this good rises The demand curve shifts when factors other than own price change: § If the change increases the willingness of consumers to acquire the good, the demand curve shifts right § If the change decreases the willingness of consumers to acquire the good, the demand curve shifts left September 2013 8
Rule A move along the demand curve for a good can only be triggered by a change in the price of that good. Any change in another factor that affects the consumers’ willingness to pay for the good results in a shift in the demand curve for the good. September 2013 9
The Market Supply Function The market supply function tells us how the quantity of a good supplied by the sum of all producers in the market depends on various factors Qs= Q(p, po, W, …) The Market Supply Curve The market supply curve plots the aggregate quantity of a good that will be offered for sale at different prices Qs= Q(P) September 2013 10
The Law of Supply Definition: The Law of Supply states that the quantity of a good offered increases when the price of this good increases. The supply curve shifts when factors other than own price change: · If the change increases the willingness of producers to offer the good at the same price, the supply curve shifts right · If the change decreases the willingness of producers to offer the good at the same price, the supply curve shifts left September 2013 11
Rule A move along the supply curve for a good can only be triggered by a change in the price of that good. Any change in another factor that affects the producers’ willingness to offer for the good results in a shift in the supply curve for the good. September 2013 12
Linear demand supply analysis Linear demand supply curves can be expressed as equations with an intercept and a slope: Q=I+S P Q = Quantity I = Intercept S = Slope September 2013 13
Linear demand supply analysis Example: Q = 220 - 4 P 100 Slope Price (P) Intercept 1 -4 0 0 September 2013 220 Quantity (Q) 14
Linear demand curves QD = I D + S D P QD is the amount of the good demanded at price P ID is the intercept for the demand curve – the amount that would be demanded if the price was zero SD is the slope of the demand curve – the change in the amount demanded when the price changes by one September 2013 15
Calculating values for a linear demand curve Example: QD = 220 - 4 P If P = 10 QD = 220 - 4 10 = 180 If P = 30 QD = 220 - 4 30 = 100 If P = 55 QD = 220 - 4 55 = 0 (No demand if price = 55) If P = 60 QD = 220 - 4 60 = -20 (Obviously impossible!) September 2013 16
Drawing a linear demand curve 100 Example: QD = 220 - 4 P If QD = 0, P = 55 Price (P) 55 If P = 0, QD = 220 25 0 0 September 2013 120 Quantity (Q) 220 17
Linear supply curves QS = I S + S S P QS IS SS is the amount of the good supplied at price P is the intercept for the supply curve – the amount that would be supplied if the price was zero is the slope of the supply curve – the change in the amount supplied when the price changes by one September 2013 18
Calculating values for a linear supply curve Example: QS = -20 + 2 P If P = 50 QS = -20 + 2 50 = 80 If P = 20 QS = -20 + 2 20 = 20 If P = 10 QS = -20 + 2 10 = 0 (No supply if price = 10) If P = 1 QS = -20 + 2 1 = -18 (Obviously impossible!) September 2013 19
Drawing a linear supply curve Example: QS = -20 + 2 P 100 If QS = 0, P = 10 Price (P) 50 10 0 If P = 100, QS = 180 0 September 2013 80 180 Quantity (Q) 20
Calculating the equilibrium point QS = -20 + 2 P QD = 220 - 4 P In equilibrium, QS = QD, therefore -20 + 2 P 6 P P* September 2013 = = = 220 - 4 P 240 40 21
Calculating the equilibrium point QS = -20 + 2 P QD = 220 - 4 P Substituting for P in the supply equation, QS = -20 + 2 40 = 60 Substituting for P in the demand equation, QD = 220 - 4 40 = 60 P = 40 Giving the equilibrium position: P = 40 and QD = QS = 60 September 2013 22
Drawing a market equilibrium Supply 100 Price (P) 55 If P = 40, Q = 60 40 Demand 10 0 Quantity (Q) 0 September 2013 60 220 23
Drawing a market equilibrium If QS = 0, P = 10 If QD = 0, P = 55 Price (P) If P = 40, Q = 60 55 If P = 0, QD = 220 40 10 0 0 September 2013 60 Quantity (Q) 220 24
Example The Market for Cranberries Qd = 500 – 4 p QS = – 100 + 2 p p = price of cranberries (dollars per barrel) Q = demand or supply in millions of barrels per year September 2013 25
Example The Market for Cranberries a. The equilibrium price of cranberries is calculated by equating demand to supply: Qd = QS … or… 500 – 4 p = -100 + 2 p …solving, p* = $100 b. plug equilibrium price into either demand or supply to get equilibrium quantity: Q* = $100 September 2013 26
Example The Market for Cranberries Price Market Supply: P = 50 + QS/2 Quantity September 2013 27
Example The Market for Cranberries Price 125 Market Supply: P = 50 + QS/2 Market Demand: P = 125 - Qd/4 Quantity September 2013 28
Example The Market for Cranberries Price 125 P*=100 Market Supply: P = 50 + QS/2 • Market Demand: P = 125 - Qd/4 Q* = 100 September 2013 Quantity 29
Example The Market for Cranberries Definition: If sellers cannot sell as much as they would like at the current price, there is excess supply or surplus September 2013 30
Example The Market for Cranberries Price 125 120 100 • Excess Supply • Market Supply: P = 50 + QS/2 Market Demand: P = 125 - Qd/4 Qd Q* 100 September 2013 QS Quantity 31
Example The Market for Cranberries Price 125 • Excess Supply • Market Supply: P = 50 + QS/2 Shortage Market Demand: P = 125 - Qd/4 Qd Q* September 2013 QS Quantity 32
Excess Supply ·If there is no excess supply or excess demand, there is no pressure for prices to change and we are in equilibrium. ·When a change in an exogenous variable causes the demand curve or the supply curve to shift, the equilibrium shifts as well. September 2013 33
Shifts in Supply and Demand Example: Coffee Beans, revisited Price per pound Supply (P, W) • Demand (P, other 2) Demand (P, other 1) Quantity, pounds September 2013 34
4. Price Elasticity of Demand: how sensitive is demand to changes in price The slope of the demand curve is one way to measure sensitivity. . . Price 10 Market Demand: Q = 50 – 5 P 7 • 5 September 2013 15 25 P increases by 2 Q falls by 10 Change in Q / change in P = -10 / 2 = -5 50 Quantity 35
4. Price Elasticity of Demand: how sensitive is demand to changes in price. . . BUT, -5 what? Price Measurement of the slope depends on units of measurement for P and Q 10 Market Demand: Q = 50 – 5 P 7 • 5 September 2013 15 25 P increases by 2 Q falls by 10 Change in Q / change in P = -10 / 2 = -5 50 Quantity 36
4. Price Elasticity of Demand is the percentage change in quantity demanded, brought about by a 1 percent change in price September 2013 37
4. Price Elasticity of Demand E. g. Market Demand: Q = 50 – 5 P P increases by 2 Q falls by 10 Change in Q / change in P = -10 / 2 = -5 Price 10 % Change in Q / %change in P = 7 • 5 September 2013 15 25 50 Quantity 38
4. Price Elasticity of Demand E. g. Market Demand: Q = 50 – 5 P P increases by 1 Q falls by 5 Change in Q / change in P = -5 / 1 = -5 Price 10 6 5 % Change in Q / %change in P = • Same elasticity? For every initial point? September 2013 20 25 50 Quantity 39
4. Price Elasticity of Demand E. g. Market Demand: Q = 50 – 5 P P falls by 1 Q increases by 5 Change in Q / change in P = 5 / -1 = -5 Price 10 6 5 % Change in Q / %change in P = • NO! September 2013 20 25 50 Quantity 40
4. Price Elasticity of Demand E. g. Market Demand: Q = 50 – 5 P P falls by 2 Q increases by 10 Change in Q / change in P = 10 / -2 = -5 Price 10 6 4 % Change in Q / %change in P = • Will this happen for every demand function? September 2013 20 30 50 Quantity 41
Example September 2013 42
Example Comparing the price-elasticity of demand on different demand curves September 2013 43
Example September 2013 44
4. Price Elasticity of Demand September 2013 45
4. Price Elasticity of Demand (intuition) • When demand is elastic, increase in q offsets the fall in price, increasing revenue. • When demand is inelastic, increase in p offsets the fall in q, increasing revenue. • When demand is unit-elastic, revenue is maximum. Note: Revenue = Consumer Expenditure = P*Q September 2013 46
4. Price Elasticity of Demand for Selected Products, Chicago, 1990 s September 2013 47
4. More Elasticities * Income Elasticity of demand is the percentage change in quantity demanded, brought about by a 1 percent change in income September 2013 48
4. More Elasticities * Cross-Price Elasticity of demand is the percentage change in quantity of good i demanded, brought about by a 1 percent change of the price of good j. > 0 then. . . < 0 then. . . September 2013 49
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